Economic Project Evaluations: Methodology - PowerPoint Presentation

1. Economic Project Evaluations: MethodologySandeep Borkar

2. AgendaWhy we’re discussing thisNPV BasicsDiscussion2Note of caution: This discussion is limited to selecting between multiple project alternatives that have met the economic planning criteria. This discussion is NOT about the criteria to used to determine if a project is economic.

3. Protocol 3.11.2(4)For economic projects, the net economic benefit of a proposed project, or set of projects, will be assessed over the project’s life based on the net societal benefit that is reasonably expected to accrue from the project. The project will be recommended if it is reasonably expected to result in positive net societal benefits. 3

4. Reason For DiscussionAn economic project evaluation methodology should: Take a societal point of view (consistent with PUCT rules and Protocols)Include all relevant costs and benefits associated with the project Transmission assets expect to provide benefits to the system over the entire life of the asset (30 years – depreciated life and more)Society incurs costs which go beyond the initial capital costNet Present Value (NPV) is commonly used for such applications4

5. Why Not to Consider Only Savings:Cost Ratio5Example: Comparison of two mutually exclusive projectsProject A:Cost = $1PC Savings = $1,000Savings:Cost Ratio = 1,000Net Benefit = $999Project B:Cost = $1,000,000PC Savings = $20,000,000Savings:Cost Ratio = 20Net Benefit = $19,000,000Net Benefit$999$19M

6. NPV BasicsNet present value (NPV) is the difference between the present value of relevant cash inflows and outflows over a period of time. NPV is used in capital budgeting to analyze the profitability of a projected investment or project. 6Ct = net cash inflow during the period tC0 = total initial investment costsr = discount ratet = number of time periods  

7. NPV Basics – Transmission Investment7None Ct = net cash inflow during the period tC0 = total initial investment costsr = discount ratet = number of time periods  Investment rate - inflation30 years – assumed depreciated life

8. DiscussionApplication of the assumptions in the previous slide to transmission investment decisions (when deciding between multiple projects)Since the NPV is a product of set financial assumptions we can use a generic NPV multiplier applied to estimated project costWhat discount rate should be used to discount:Production cost savings?[Alternatively, don’t discount PC savings – calculate/ interpolate from LTSA]Annual carrying costs?8

9. Questions and Comments9Please send comments to Sandeep Borkar.Sandeep.Borkar@ercot.com

10. Appendix10

11. Annual Carrying Cost of a Transmission ProjectCapital cost of the project (the price to a TO)Return on Rate BaseCost of debtCost of equityTaxesIncremental Operations and Maintenance expenses (O&M)11 ItemYear 1 Return on Rate Base $ 19,509 Depreciation $ 8,798 Fixed O&M $ - Variable O&M $ 2,601 Ad Valorem Tax $ 2,621 Federal Income Tax $ 1,112 Annual Revenue Req $ 34,641 Capital Cost$ 250,000 PV of Total Revenue Req$ 554,410 PV of Total Revenue Req (ignoring taxes)$ 440,324For a sample TDSP

12. Revenue requirement snapshot for first three years12Year (index)123Year202220232024Return on Rate Base $ 19,509.40 $ 18,987.86 $ 18,333.11 Depreciation8797.508797.508797.50Fixed O&M0.000.000.00Var O&M2601.002653.022706.08Property Taxes2621.352551.282463.30FIT1112.21787.99982.12Total Revenue Requirement $ 34,641.46 $ 33,777.65 $ 33,282.11 Total Revenue Requirement (w/o Taxes) $ 30,907.90 $ 30,438.38 $ 29,836.69 Sample capital cost of project : $250MAll $$ expressed in ThousandsSL depreciation over 30 yearsFIT determined at 21% and 1% O&M is assumed